Joe Versus the Volcano — Joe’s Jeans erupts

As it is the case for all postings in this blog, my standard disclaimers apply for this posting.  However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice.  Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.

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4711354273_7a56511307_bOn September 14th, 2013 I posted a comprehensive article about Unitek Global Services, focusing on a potential setup through an entirely legal, but totally questionable, accounting gimmick that I had uncovered in the company’s recent 10K restatement (read the posting here.)

As I noted in the posting I recognized the setup because I had seen precisely the same accounting gimmick, technically known as a release of a valuation allowance, executed for Joe’s Jeans.

As I wrote:

Joe’s Jeans …. pulled the proverbial rabbit out of an accounting hat, utilizing an obscure tax rule that allowed for the release of its valuation allowance. As the company wrote in its 10K filing for the 2009 fiscal year:

A valuation allowance is required when it is more likely than not that all or a portion of a deferred tax asset will not be realized. Periodically, management reassesses the need for a valuation allowance. Realization of deferred income tax assets is dependent upon taxable income in prior carryback years, estimates of future taxable income, tax planning strategies and reversals of existing taxable temporary differences. Based on Joe’s assessment of these items during the fourth quarter of fiscal 2009, Joe’s determined that it was more likely than not that the deferred tax assets would be fully utilized. Accordingly, the valuation allowance of $20,291,000 as of November 30, 2008 was released and recorded as a credit to income tax benefit during fiscal 2009.

On the income statement, more than 75% of these $20.3 million went towards net income, causing the company to register net income of 24.5 million in its fiscal year 2009, compared to $4.9 million in fiscal year 2008 and $2.5 million in fiscal year 2007.

Expecting this one-off events to be repeatable (it is not) and following quarters to show net income in the tens of millions or dollars (they did not,) the market, which appears to be unable to read filings, went crazy, lifting the per share price to almost $3 before the quarters were reported in 2010, causing a per share price collapse in April of 2010.

OK, so where is this going, you ask?

It is events like these that, for a long time, have caused Joe’s Jeans to be a really bad investment, while JOEZ, the company’s equity, has been an excellent trading object — assuming that you were really lucky or really good (very few traders are — read more about the amazing losses accumulated by virtually all traders here.)

I won’t get into additional details about the many events that have caused Joe’s Jeans to be a bad investment while JOEZ were an excellent trading object. If you are really interested in understanding why (or, rather, get a taste of why,) you can start by taking a look at a recent article by Ms. Nancy Gondo in Investor’s Business Daily (here,) keeping in mind that Ms. Gondo misses out on a number of large factors, including the above-mentioned accounting gimmick and a near-catastrophic compensation agreement with Joseph M. Dahan, the company’s creative director (an agreement that was so stupid in size, scope, and structure, and, ultimately, in my opinion, hurt the stock-price to such an extent, that it it a wonder that it has not cost Mr. Marc Crossman, the company’s CEO, his job.)

In line with my investment paradigm, I have followed Joe’s Jean for more than five years, routinely discarding it as an investment object. In 2013, however, I started paying close attention when two things happened: First, the company restructured its agreement with Mr. Dahan, creating an agreement that was not great, but, at least, was manageable and contained; and, second, the company acquired Hudson Clothing Holdings, Inc.

The acquisition is interesting. It is sizable and will seriously grow the company, and it is debt-based, requiring Joe’s Jeans’ management to operate with a new set of rules and increased discipline.

I won’t go into all the details, but the upshot is that towards the end of last year, I revisited my thinking on Joe’s Jeans, and began accumulating a position in JOEZ.

My position is now quite sizable with an attractive average cost basis, providing for plenty of margin of error, and I am in waiting mode.

Since I took my position, the per share price of JOEZ has grown just about 20% in a quite undramatic way. Today, however, something happened when Mill Road Capital, an investment fund out of Greenwich, Connecticut (a location where a number of large investment funds operate out of,) in a SC13 filing, disclosed that it had accumulated 3.5 million shares of JOEZ in the open market, representing approximately five percent of the float, causing significant post-market volatility, swinging the per share price from $1.23 to a high of $1.46 (a 19% rise in the per share price) before it settled back at $1.35 (a 10% rise.)

Mill Road Capital is not, of course, a proxywallflower, having run rings around the management of several companies over the years, including a quite nasty proxy battle with Kona (the proxy card can be found here, and you can find an article by Mr. Josh Beckerman in the Wall Street Journal article about the matter here,) so, given the rather shaky performance of the per share price of JOEZ over the last five years, this certainly has potential for being interesting.

On a side-note, it appears that Mill Road Capital is quite restaurant centric, so it is interesting to see what they make of Joe’s Jeans’ business.

Most of the SEC filing from Mill Road Capital is pretty much standard boiler language, including the rationale section:

The Reporting Persons acquired shares of the Common Stock based on their belief that the Common Stock represents an attractive investment opportunity, and such purchases have been made in the Reporting Persons’ ordinary course of business.

However, as always, the acquisition schedule, disclosing the actual sums and sizes of the purchase chunks, is very interesting, revealing that the largest purchase chunk, 1.6 million shares, was secured in the middle of January at a per share price that is considerably higher than my average costs.

I, for one, welcome Mill Road Capital to the party. I still hold on to my position and wait, but now I follow the developments with a bit more interest.

Dont be a Mooch!

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